The stock market crashed in ’29. The market then bounced. After a few months almost everyone was persuaded that the “worst is over.” But the worst was just beginning. It wasn’t until 1932 that the stock market finally hit bottom. By then, it beginning to seem like a depression… and only years later did economic historians tag it as a ‘great’ depression.

This depression is still wet behind the ears… We’re still in the bounce phase. On Friday, the Dow went 113 points higher. And as the bounce continues, more and more investors will come to believe that stocks are in a new bull market and that the economy is back in growth mode.

Neither will be true.

The stock market is in a bear market rally, not a genuine bull market. The economy is entering a long depression… possibly a ‘great’ one.

How can we be so sure? Well, we’re not sure of anything. But all the signs point in that direction. Household debt as a percentage of disposable income hit a low of about 2% just at the end of WWII. It’s been going up ever since. By 2005 it nudged against 15% — 7 times higher than it had been 60 years earlier. Household debt represents spending that has been taken from the future.

But you can’t take an infinite amount from future earnings. You reach a point when the future can’t handle it. As more and more future earnings are absorbed by past consumption, pretty soon there’s not enough left to live on. At some point, so much of earnings are devoted to paying the interest and principle on past borrowings that the poor householder cannot to pay his expenses. And imagine what happens if his disposable income goes down.

Guess how many jobs the US private sector has added over the last 10 years? Almost none. Private sector employment is back to levels of 1999. There are more jobs in restaurants and health care… but many fewer in manufacturing. Net gain: zero.

The only job gains have been in the parasite sector – government. On the evidence, this trend is going to continue. Now, the feds have a new post called “pay czar.” As near as we can tell this is a busybody who undertakes to control salaries in the industries that the feds have bailed out.

There will be a lot more jobs running the regulatory/bailout apparatus. Then, too, there are all the make-work jobs of the shovel ready boondoggles the feds began in an effort to replace private spending.

Back in the private sector, 72 banks have failed so far this year. And a record 34 million Americans are getting food stamps.

Naturally, incomes are falling. Now, imagine the consumer… he’s already paying 15% of his disposable income to debt service… and then his income is cut in half! This means that 30% of his remaining income must be used just to service the debt. Impossible to do without big cuts in spending…

The poor consumer hit the wall in 2007. He was spending all he earned… and paying more of his income in debt service than at any time in the last 60 years. He couldn’t continue to live on future earnings – there just weren’t enough of them. That is why the finance industry has topped out. It loaded Americans up with enough debt already.

And it’s why the credit cycle has turned. All of a sudden savings rates are back up to 7%. Consumers are cutting back… raising chickens in their back yards… driving less… planting gardens and squeezing their nickels. The private sector is de-leveraging. And there won’t be any durable economic boom or lasting bull market on Wall Street until this process is finished.

How long will that take? Read on…

*** Harvard professor Ken Rogoff says it will take 6-8 years for households to reduce their debts to a more sustainable level. Let’s see. We reported on Friday that the big upswing in credit over the last 60 years added about $35 trillion in excess debt to the system. But not all of that is private debt.

Taking the period of the bubble years, in 2000 total debt in the US came to $26 trillion. Now, it’s twice that amount — $52 trillion, of which $38 trillion is private… or more than 2 and a half times GDP. At this level, the private debt absorbs roughly one out of every 7 dollars in consumer earnings – in interest and principal payments.

If the private sector undertook to reduce debt back to 2000 levels, it would mean eliminating all the debt accumulated during the bubble years – or about $19 trillion. How long will it take to pay down, write off, inflate away and otherwise shuck $19 trillion?

Well, inflation is running below zero – so that is not now a source of debt reduction. Between write-offs and pay-downs, about $2 trillion has already been cut – over, very roughly, the last 2 years. At least the math is easy. At that rate, it will take 19 years.

Now, let’s go back and look at the Japanese. How long have they been deleveraging. Gosh all mighty… 19 years. From 1990 to 2009.

Are we looking at a 20-year period of on-again, off-again deflation… of bear market rallies followed by real bear markets… of weak employment and weak or no growth? That’s what we argued, along with Addison Wiggin, in our first book, Financial Reckoning Day. Then, the stock market took off… and the bubble years came. It looked like we were dead wrong. Maybe we were just early. Or maybe those bubble years were just a feint… a fake-out that convinced the entire world to invest in stocks and property, just before the biggest crash in history.

In that book, we guessed that the crash in the tech sector marked the beginning of the end. By 2005, it didn’t seem at all as though we were in a down-cycle. But adjusted for inflation, stocks never beat their January 2000 high. And outside of government, the economy has no more jobs than it did in 1999. We’ve had wars against terror, bubbles in practically every sector, trillion-dollar boondoggles, bailouts, bamboozles and Michael Jackson’s tragic cooling… but what is the only durable thing to come out of the last 10 years? Just Google and debt.

*** “When you have a big family there is always someone in the family who is in trouble,” said another friend.

“I thought that when the children left home to go to college, we’d be more or less free from problems. They’d be on their own. We could turn our attentions to other things.

“Well, it didn’t turn out that way. There’s always one of them that has a problem. And we spend a fair amount of time worrying about them… even if there’s nothing we can do to help. Or trying to help them if we can…

“And then the grandchildren come… and then we worry about them. It just goes on and on. It’s not disagreeable, of course. I’d rather have children and grandchildren to worry about than not have them. But there doesn’t seem to be any end to it… ”

Source: Still in the Bounce Phase

Yesterday, the Dow lost another 131 points. Another big day down and it will be in the
7,000-range. Oil sank too – down to $62. The dollar, bonds, and gold stayed about where
they were.

Economists are still talking about an “exit strategy.” But in view of what is actually going
on in the economy, they’ll probably want to stay on this highway a lot longer. This is the
long road to ruin, of course. It may be fatal, but it is not – yet – unpopular.
Broadly, what is happening is exactly what should be happening.

The stock market rally is getting old…and may have already peaked out. The consumer is
running out of time, money and credit. He has no choice but to cut back. Savings rates are
rising fast – from zero to about 5% of disposable income.

Naturally, businesses are finding it hard to make sales. Earnings are collapsing…stock
dividends are down sharply…

…and of course, businesses try to cut expenses by lightening up on their payroll.
When the correction began, it was led by losses in the financial sector. Those losses led to
cutbacks throughout the economy. Now, it’s the cutbacks that are leading to financial
losses. The economy followed the markets; now the markets follow the economy.
Investors are realizing that their favorite companies will find it hard to prosper in this
new economic environment.

“US consumers fall behind on loans at record pace,” says a Reuters headline.
Delinquencies are going up on a wide range of household debt. Debtors have never had
such a hard time keeping up with payments. Credit card delinquencies, for example, are
running at 6.6%.

Well…duh.

And no wonder “banks get stingy on credit,” as reported in the USA Today. “Despite
massive government efforts to bolster the credit market, banks are pulling back severely
on card lending,” begins the front-page article.

Once again, we see the feds’ plans failing. They give trillions to the bankers; the
bankers cut back on consumer credit. And why shouldn’t they? They can see what the
rest of us see – the consumer can’t keep up with the debt he’s got already.

“Consumers aren’t going to be able to save the U.S. economy this time,” The
Richebacher Letter’s Rob Parenteau reminds us.

“Total U.S. retail sales have rolled back to levels we haven’t seen since 2005. Imagine if
every single retail shop opened in the last three years shut down overnight. It’s already
that bad.

“A lot of people, from Wall Street to Washington, have a great deal invested in you
believing we can reverse that trend. But, in actuality, the freeze in consumer spending
and the consumer economy could actually take many more years to thaw.”

At least, the consumer has wised up. He’s sick of debt. He’s seen where that road leads.
What he wants is to get out of debt…to be free…to be safe.

It’s the government that remains stuck in deep illusion… The feds know that it was too
much credit that got consumers into trouble. Their solution? Give them more credit!
The banks are issuing fewer credit cards than they did last year – 38% fewer. They’re
pushing credit limits down too – the average limit on a new card is down 3% so far this
year.

Instead of passing money on to customers, the banks are using the feds’ free cash to build
up their own reserves…raise their salaries…and pass out bonuses. Makes sense. What else
could they do with it?

“Uighurs are beasts” shout crowds of Han Chinese in the remote northwest of the
country. Uighurs are the Moslem minority. Han Chinese are the majority. And, judging
from the photos, the Han want to kill the Uighurs.

One thing smart people always do is to underestimate the power of foolishness. It is
wild and reckless to stir up a race war. But that doesn’t stop people from doing it. Any
kind of war is a blow to reason and civilization. But that hasn’t made war unpopular,
even among the most reasonable and civilized people on the planet.

It was within the lifetimes of many people reading this Daily Reckoning that the most
advanced countries on earth began a war of annihilation. At the beginning of the 20th
century, high culture and science were dominated by Germans. German musicians and
composers…German poets and writers…German mathematicians, physicists, painters,
philosophers – even the German economy was a world leader, second in output only to
the United States of America.

Then, the Germans went off their heads – along with the Italians, the Russians, the
Japanese…and many others.

But the Han have it right. The Uighurs are beasts from time to time. So are the Han…the
Teutons…the Anglo-Saxons…and all the tribes on earth. Occasionally, for no apparent
reason, the masks and restraints of civilization give way to mobs…and the old beast starts
howling at the moon.

It happens in markets too. What is a bubble, if not a wild and reckless thing? A kind
of madness? A mass illusion…a foolishness, in which people leave reason and civilization
behind?

What if the United States had to pay its debt in gold?

In the old days, before the monetary reforms of the 20th century…notably, Richard
Nixon’s unilateral decision to renege on America’s promise to pay its bills in
gold…countries had to settle up with each other in the yellow metal. The system worked
well; it was reliable; it prevented bubbles. Edward Chancellor explains:

“A country had to pay for its imports or foreign investments with money gained from a
surplus on trade. If more money was sent abroad than had been earned through exports,
then gold would be packed onto ships to discharge foreign creditors. A declining stock of
bullion would induce the central bank to raise interest rates in order to attract gold from
abroad. Rising rates would produce a credit contraction, unemployment and general
economic misery. The typical nineteenth century was severe, but short-lived.”

Then came the improvements. And the Great Depression. And now we are faced with
another one.

Governments are fighting this one…just as they did the last one…but with much more
money. The cost is in the trillions – most of it in the form of public debt. How will
these debts be paid? We all expect that they will ultimately be eased by inflation – in
full or in part. But suppose the feds had to pay up in real money?

Colleague Simone Wapler compared government debt to government gold. The United
States has gold worth about $241 billion, she reports. Its official national debt is $11.5
trillion. That gives it a debt/gold ratio of 48 – meaning; the feds have 48 times as much
debt as gold.

Britain is even worse. Prime Minister, then Chancellor, Gordon Brown sold much of
England’s gold at the worse possible moment – about 10 years ago. This leaves the island
with only $9 billion worth of gold compared to $1,274 billion of government debt – a
ratio of 1 to 139. But Japan is the worst of all. It has $23 billion worth of gold and $7.3
trillion of government debt, for a ratio of 1 to 323. (Of course, Japan has vast holdings of
dollars too!)

What nation has the best gold/debt ratio? Switzerland. It has only twice as much in
government debt as it has in gold.

Source:The Long Road to Ruin

When consumer debt is high, the only way to increase consumer spending is by (a) increasing the consumers’ take home pay or (b) forgiving a portion of consumer debt (which isn’t even guaranteed to prevent a default on that debt).

This year alone, over 2.9 million Americans have lost their jobs. So expecting a better paying job is out of the question. The government is already searching for ways to increase taxes, so we doubt consumers will get any significant tax cuts. And considering Team Obama is so keen to protect the banks, chances are they aren’t going to be pardoning consumer debt.

Let’s be frank. Consumers aren’t making more money this recession. And what money they do have will be spent to pay off their debt. That means discount retailers – the ones that sell everyday items for cheap – will lead the retail sector for some time to come. One of the best is Dollar Tree, Inc. (NASDAQ: DLTR).

The stock market might bounce for a while, global currencies might stabilize for a while, but don’t be deceived, large problems remain…very large problems. And the price to fix these problems will run into the tens of trillions of dollars. That’s the kind of price tag that could ruin a national currency or two…even the world’s reserve currency.

While equities continue to go up and up, most of us are left scratching our heads. Is this the real thing or will it go down in history as ‘just’ another bear market rally? Not so long ago, the entire financial system stared Armageddon in the face. Now, only a few months later, equity markets behave as if all the worries of yesterday have been washed away.

The dangerous conclusion to draw from the experience of the past few weeks is that all is now well and dandy and it is time to load up on stocks again. I cannot emphasize it strongly enough: The bull market of March-April 2009 is almost certainly a bear market rally. As one of my partners pointed out the other day, NYSE saw four 20%+ rallies between 1929 and 1932. Bear market rallies can be extremely powerful and hence deceiving.

But the problems are not over yet. Not by a long stretch. It will take longer than 18 months to unwind the excesses of the past 25 years. Analysts at Morgan Stanley reckon that the 15 largest banks, which between them have shrunk their balance sheets by about $3.6 trillion so far in this crisis, will shed another $2 trillion in 2009. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off than the banks, with total household debt now at 96% of GDP vs. 47% in 1982.

The IMF reckons that both European and US banks – but in particular the European ones – are well behind the curve in terms of recognizing their credit crunch related losses. According to the IMF, there is at least another $1.5 trillion to come.

As the recession bites into the lives of ordinary people, banks will face losses not only on sub-prime mortgages but on all loan products. In fact, sub-prime is indeed a small fraction of the total loan book for the US banking sector. Prime and Alt-A mortgages, together with commercial real estate loans total about seven times the size of the subprime market.

Delinquencies are now on the rise on all mortgage products; however, whereas sub-prime started to deteriorate as early as 2007, it is only recently that delinquencies related to Alt-A mortgages have taken off, and prime and jumbo loans are only now starting to suffer.

These defaulting mortgages pose a very serious threat to the U.S. economy, but they are only part of the economic crisis worldwide. By far my biggest concern at the moment is the enormity of the debt problem facing most OECD countries. In the March issue of the Absolute Return Letter, I referred to an important study conducted by Carmen Reinhart and Kenneth Rogoff back in December of last year.

Reinhart and Rogoff studied every banking crisis of the past generation and made some startling observations. One in particular caught my attention. According to the authors, governments inevitably underestimate the ultimate cost of a banking crisis, because the indirect costs (such as falling tax revenue in subsequent years) end up much higher than predicted.

The IMF estimates that the cost of the current crisis to the United States will eventually reach 34% of GDP or close to $5 trillion. However, the Obama administration, through its various implicit and explicit guarantees, is already using a number close to $9 trillion. And Reinhart and Rogoff’s historical average of 86% of GDP implies an ultimate cost of over $12 trillion!

The true cost is important, because it has to be financed through new bond issuance, and it is my thesis that the sheer size of this tsunami will eventually overwhelm the world’s bond markets. Even using the relatively conservative IMF estimates, the twelve largest industrialized countries of the world will have to issue about $10 trillion worth of new bonds to cover the cost of the current crisis.

However, if you (like me) believe that IMF underestimates the true cost of this crisis, Reinhart and Rogoff offer a more realistic approach. Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn’t even bother to produce a worst case scenario – it all got too depressing!

I need to put the $33 trillion into perspective. Total global savings (loosely adjusted for the big losses in 2008) are probably somewhere in the region of $100 trillion. In other words, financing this crisis could absorb one-third of total global savings.

Hence it comes down to the price at which governments can attract sufficient demand from people like you and me. One of two things may happen. Either this crisis will ignite such a bout of deflation that investors will happily own government bonds yielding 2-3% or the deflation scare goes away ultimately, the global economy recovers and bond investors demand much higher yields for taking sovereign risk. I am not yet sure which scenario will prevail, but I do know that both are quite bad for equities longer term.

There is a third route, of course. Governments could print money for themselves, which they could then use to purchase their own bonds. We call that process inflation…and it is already underway.

Source: He Who Borrows the Most, Wins

There seem to be plenty of lamebrains that think that the federal government sending out $168 billion in “tax rebate economic stimulus” checks to various people, for no reason at all, is some hot idea that is going to somehow magically save the American economy.

Instead of calling these people names like “moron”, “stupid moron” or “big, dumb, poopie-head moron” like they deserve, I merely motion to Boris Sobolev of ResourceStockGuide.com to tell you that “the worst in the economy is not yet over, especially if one recalls just a couple of important facts from a very long list of economic headwinds: (1) Gasoline and heating oil prices are at their all-time-highs, while (2) household debt is 85% higher than it was in 2001, the year we received our first rebate checks from the government.” Yikes! 85% higher debt in 7 years!

And it is not just energy that is costing more, but Ambrose Evans-Pritchard at Telegraph.co.uk writes that everything is costing more, everywhere, and “Argentina has inflation that is running at about 25pc, even though the official Consumer Price Index (CPI) is 8.9pc”, which is plenty bad enough, but that he goes on “Among the CPI rates – if you believe them – are: Ukraine (30pc), Venezuela (29pc), Vietnam (25pc), Kazakhstan (19pc), Latvia (18pc), Qatar (17pc), Pakistan (17pc), Egypt (16pc), Bulgaria (15pc), Russia (14pc), the Emirates (11pc), Estonia (11pc), Turkey (9.7), Indonesia (9pc), Saudi Arabia (9.6pc), Romania (8.6pc), China (8.5pc) and India (7.6pc).”

I am staggered by all of this inflation, and in desperation I turn to Jeff Rubin of CIBC World Markets, who says that their new report says, “Exploding transport costs may soon remove the single most important brake on inflation over the last decade – wage arbitrage with China”

How “exploding” are these transport costs? Well, the report finds that “the cost of shipping a standard 40-foot container from East Asia to the North American east coast has already tripled since 2000 and will double again as oil prices head towards US$200 per barrel.” Double!

The report notes that “it currently costs US$8,000 to ship a standard 40-foot container from Shanghai to the North American east coast, including in-land transportation. That’s up from just US$3,000 in 2000 when oil was US$20 per barrel. At US$200 per barrel of oil, the cost to ship the same container is likely to reach US $15,000.”

To see how this is reflected in prices, Mr. Rubin says, “To put things in perspective, today’s extra shipping cost from East Asia is the equivalent of imposing a nine per cent tariff on East Asian goods entering North America. And at oil prices at US$200 per barrel, the tariff equivalent rate will rise to 15 per cent.”

I know what you are thinking. You want to know how in the hell you can afford to buy anything if prices are raised another 15% just for transportation costs, and if things are as bad as I say, why aren’t people screaming mad, barricading themselves in their homes, putting “no trespassing” signs all over the yards and buying gold and silver?

Well, as to the first question, I rudely reply that I don’t expect you to buy anything since I can’t afford to buy anything, either, you greedy, self-absorbed little snot; and furthermore I am (now that you mention it) screaming mad; I’m barricaded in my house; there are a zillion “Trespassers will be shot!” signs all over the yard; and I am buying gold and silver with every dime I can steal from my wife’s purse or the kids’ piggy banks.

And some others are apparently catching onto that gold idea, too, as GoldenSextant.com reports that “Another intriguing development of the past few months is the resumed outflow of foreign earmarked gold from the United States. From the end of 2003 through January of this year, there was virtually no change in the total amount of gold held under earmark at the New York Fed for foreign and international accounts, mostly foreign central banks. However, from February through September, the latest month for which figures are available, these accounts are down by a net 169 tonnes, from $8,967 to $8,737 million at $42.22/ounce, or from 6,606 to 6,437 tonnes.”

But excitingly, if you like the idea that there has to be a lot of buying of gold in the future, even as the amount of Federal Reserve gold is going down, that the derivatives industry have made a monster that will devour them, as “The reported figures indicate that the mountain of gold options now almost certainly exceeds 30,000 tonnes – an amount roughly equal to the world’s total claimed official gold reserves.”

So all the gold in the world is owned twice over? Hahaha! I smell a short squeeze a-coming, which will be wonderful for those holding real gold! Whee!

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Source: How to Remain Calm During a Price Explosion